309 Chapter 17________________ Corporate Reorganizations —————————————————— ——— SUMMARY OF CHAPTER This is the capstone chapter in corporate taxation. Students must understand corporate formations (Code Sec. 351), distributions and redemptions (Code Secs. 301-304, 311, 316), and liquidations (Code Secs. 331-338) before reorganizations become meaningful. Thus, Chapters 13-15 should be reviewed as needed. Types of Corporate Reorganizations ¶17,001 Statutory Definitions There are seven basic types of corporate reorganization defined in Code Sec. 368. They are referred to by the subparagraph in which they are defined (e.g., Code Sec. 368(a)(1)(A) defines a Type A reorganization). ¶17,005 General Requirements In order to receive non-recognition treatment, the transaction(s) must have been completed pursuant to a plan of reorganization. No gain or loss will be recognized if stock or securities in a corporation that is a party to the reorganization are exchanged solely for stock or securities of the same corporation or of another corporation that is a party to the reorganization. If ‘‘boot'' is received, a realized gain will be recognized to the extent of the boot received. ¶17,009 Type A Reorganizations This type of reorganization involves the acquisition of assets and includes statutory mergers and consolidations. A merger occurs when one corporation absorbs another; a consolidation occurs when two or more corporations combine in a new corporation, the former ones dissolving. This type of reorganization is the most flexible in that boot can constitute up to 50 percent of the consideration that is used to make the acquisition. A major disadvantage is that all liabilities of the acquired corporation (including contingent and unascertained liabilities) must be assumed by the acquiring corporation. ¶17,015 Receipt of Boot If a shareholder or security holder receives cash or other property (i.e., boot) in addition to the stock or securities that are permitted to be received without the recognition of gain, then a realized gain must be recognized to the extent of the lesser of (1) the realized gain or (2) the fair market value of the boot received. The distributee's basis for boot property is the property's fair market value. ¶17,025 Character of Recognized Gain After the amount of recognized gain is computed, its character must be determined. If an exchange has the effect of a dividend, then a shareholder's recognized gain must be treated as a dividend to the extent of the shareholder's ratable share of earnings and profits. Any additional recognized gain in excess of the amount to be treated as a dividend will be treated as a capital gain. ¶17,053 Type B Reorganizations The acquiring corporation must use solely voting stock to acquire control (i.e., at least 80 percent) of the acquired corporation. Solely voting stock must be used; no boot is permitted. The acquired corporation remains in existence as a subsidiary of the acquiring corporation. ¶17,105 Type C Reorganizations This type of reorganization involves the acquisition of substantially all the properties of one corporation by another in exchange solely for all or a part of the acquiring corporation's voting stock. In determining whether the acquisition has been made solely for voting stock, the assumption of liabilities by the acquiring corporation is generally disregarded. However, if the acquiring corporation exchanges money or other property in addition to voting stock, then at least 80 percent of the total fair market value of all the acquired corporation's property must be acquired for voting stock. ¶17,157 Type D Reorganizations This type of reorganization involves a transfer by a corporation of part or all of its assets to another in exchange for stock or securities, as long as immediately after the transfer the transferor owns sufficient stock to control the transferee, and the transferee's stock and securities are distributed to shareholders of the transferor in a transaction that qualifies under Code Sec. 354, 355, or 356. A Type D reorganization is often divisive and may take the form of a spin-off, split-off, or split-up. ¶17,165 Gain Recognized in Divisive Transactions Rules are imposed to prevent disguised sales of a subsidiary by the parent corporation that avoid any corporate-level tax. Thus, recognition of corporate-level gain on a distribution of subsidiary stock otherwise qualifying under Code Sec. 355 is required if, immediately after the distribution, a shareholder holds a 50-percent-or-greater interest in a distributed subsidiary (or the distributing corporation) that is attributable to stock that was acquired by purchase after October 9, 1990, and within the five-year period ending on the date of the distribution. In such case, the distributing corporation must recognize gain just as if had sold the distributed stock to the distributee for its fair market value. ¶17,217 Type E Reorganizations A Type E reorganization is a recapitalization (i.e., a change in the debt-equity structure) of a single corporation. For example, an exchange of stock for stock or of securities for stock in the same corporation would be a Type E reorganization. ¶17,277 Type F Reorganizations This includes a mere change in identity, form, or place of organization of a single corporation. For example, a change of the state of incorporation, or a name change (e.g., from International Harvester to Navistar) would be a Type F reorganization. ¶17,285 Type G Reorganizations This type of reorganization takes place while a corporation is insolvent or is in bankruptcy proceedings. Considerations for Non-recognition Treatment ¶17,321 Reorganization as an Alternative to Liquidation In a liquidation, gains and losses are generally recognized to the liquidating corporation as well as to shareholders. Alternatively, realized gains and losses are not generally recognized in a corporate reorganization because the assets remain in corporate form. ¶17,351 Use of Subsidiaries in Reorganizations A corporation can frequently use a controlled subsidiary to facilitate an acquisition in a Type A, B, or C reorganization. The two primary advantages of using controlled subsidiaries in reorganizations are that shareholders of the parent corporation do not have to approve the acquisition, and the parent corporation is protected from incurring the liabilities of the acquired corporation. ¶17,375 Post reorganization Transfers to Subsidiaries Once an acquiring corporation has acquired assets or stock in a reorganization, it may subsequently transfer all or part of the assets or stock to a controlled subsidiary in a Type A, B, C, or G reorganization. Carryover of Tax Attributes ¶17,457 Introduction Code Sec. 381 provides for the carryover of tax attributes in certain types of reorganization and liquidation. However, Code Secs. 269 and 381-384 limit the use of these carryovers by the acquiring corporation. ¶17,465 Attribute Carryover Transactions The tax attributes (e.g., NOL carryovers, earnings and profits) of the acquired corporation generally carry over to the acquiring corporation in an A, C, acquisitive D, F, or G reorganization, and in a Code Sec. 332 liquidation. ¶17,473 Limitations on Carryovers All tax attributes generally carry over to the acquiring corporation, both favorable (e.g., net operating losses) and unfavorable (e.g., earnings and profits). ¶17,481 Net Operating Loss Limitation The amount of an acquired corporation's NOL carryover that can be utilized by the acquiring corporation for its first taxable year ending after the date of acquisition is limited by Code Sec. 381(b) to the amount of the acquiring corporation's taxable income that is allocable to the days in the taxable year that follow the acquisition date. ¶17,485 Ownership Changes—Annual Limitation When there has been a more-than-50-percentage-point ownership change, Code Sec. 382 limits the amount of taxable income that an NOL carryover can offset. The amount, called the ‘‘Code Sec. 382 limitation,'' is equal to the value of the loss corporation's stock immediately before the ownership change multiplied by the highest long-term municipal bond rate in effect during the three-month interval ending with the month of change. ¶17,497 Earnings and Profits A deficit in the acquired corporation's earnings and profits can be used only to offset the acquiring corporation's earnings and profits that are generated after the acquisition date. Judicial Requirements ¶17,517 Introduction In addition to satisfying one of the specific definitions of a reorganization found in Code Sec. 368, a transaction must meet certain judicial requirements in order to receive reorganization treatment. ¶17,525 Business Purpose The transaction must have a valid business purpose other than tax savings. ¶17,533 Continuity of Proprietary Interest The shareholders of the acquired corporation must receive stock in the acquiring corporation at least equal in value to 50 percent of the value of all the acquired corporation's formerly outstanding stock. ¶17,541 Continuity of the Business Enterprise The transferor's historic business must be continued, or a significant portion (i.e., 1/3) of the acquired corporation's historic assets must be used in a business. ¶17,549 Step Transactions Transactions that are dependent on each other may be stepped together to determine whether the various reorganization requirements are met. For example, the overall result of multiple transactions may be considered to determine whether an acquisition of stock has been made for solely voting stock, or to determine whether substantially all of a corporation's assets have been acquired. ¶17,557 Liquidation and Reincorporation A liquidation followed by an incorporation may be treated as a Type D reorganization. As a result, assets will have a carryover basis, and tax attributes such as earnings and profits will carry over to the newly formed corporation. ¶17,569 Acquisitions Made to Evade or Avoid Income Tax Certain losses and deductions may be disallowed if it is determined that the primary purpose of an acquisition is to secure the deductions and losses and, as a result, evade or avoid income tax. ANSWER TO KEYSTONE PROBLEM—CHAPTER 16 (¶16,261.) 1. On liquidating sales, the corporation will recognize losses, typically ordinary and/or Code Sec. 1231 losses. These losses will offset operating income if incurred late in the year. If the liquidating sales take place early in the year, before any substantial operating income has been generated, a net operating loss will result. However, since an NOL may be carried back two years, it will generally make no difference when during the year the liquidation takes place. 2. If the stock has appreciated in value, a step-up in basis to fair market value will take place at death, whereupon the corporation may liquidate tax-free at the shareholder level. However, if the stock has depreciated, the liquidation should take place prior to the shareholder's death, so as to avoid the step-down in basis to estate tax value.